Let Sterling Slide – What Matters Now Is QE

The pound has had a slightly less volatile week. While dipping back below $1.20 on Tuesday, sterling has recovered to just under $1.23 at the time of writing. Despite the rally, the UK currency is still around 5pc down on its dollar value before early October’s Conservative Party conference – where Prime Minister Theresa May hinted she would opt for a “hard Brexit” settlement, one ruling out “membership of the single market” and prioritizing stricter immigration controls.

This fall in the pound has been sparked, as opposed to caused, by these early political skirmishes linked to the UK’s exit from the European Union. There are solid, fundamental reasons, in other words, beyond Brexit, why the pound needed to come down For starters, the UK has the largest current account deficit in the G7 – among the biggest in our peacetime history. Our annual budget deficit, despite years of “austerity”, also remains extremely large.

Over the last two and a half years, the pound has fallen almost 30pc against the dollar. That’s around the same as the drop we saw between early 1975 to mid-1977, the two and a half year period during Britain went “cap in hand” to the International Monetary Fund for a bail-out.

This shouldn’t surprise us. The UK’s budget deficit over the four years leading up to the 1976 IMF crisis had averaged 4.7pc of GDP, with an external imbalance of 4pc of national income. Today, those numbers are even worse, our 4-year budget shortfall now averaging 5.6pc of GDP, with our current account deficit at 5.9pc. The pound has fallen, then, during the four months since the UK voted for Brexit, because it had to.

Yes – this latest fall has been too far and too fast. Overly-confident pre-referendum predictions of a Remain victory, which pushed the pound too high, combined with current political argy-bargy, mean sterling has now overshoot downwards. But, on balance, a lower pound makes sense. That’s why, in September, export volumes surged to a three-year high.

Is it really the case, as mainstream broadcasters constantly tell us, that currency traders are selling the pound on fears we will quit the EU’s hallowed single market? Such analysis just doesn’t stake up.

The UK runs a £60bn trade deficit with the EU, despite single market access, while generating a £30bn surplus when trading with the rest of the world, with no single market. The EU is a declining bloc, its GDP growth having lagged every other region for a generation. The 85pc of the world economy outside the EU is growing far faster, offering Britain all kinds of trading opportunities.

In 1999, 61pc of our trade was with the EU, now it’s 43pc. Our non- EU trade is rising, in surplus and makes up the majority of our overseas commerce. Our EU trade is falling, in deficit and increasing overshadowed by UK business elsewhere. Is the single market all it’s cracked up to be? The evidence suggests not.

Then there’s that scurrilous myth that you need to be “inside the single market” to trade with the EU. The US, China, Japan and Australia all enjoy “access to the single market”, as long as they meet the EU’s regulatory standards. The same will hold for a Brexited Britain, especially once the powerful French and German industrial lobbies, mindful of their huge surpluses with the UK, start flexing their muscles, pushing the bickering eurocrats to one side, while silencing nonsensical “Britain must pay” rhetoric from grand-standing politicians.

Low EU growth and the single market’s inflexibilities, which favours trade in goods over the UK’s strategic advantage in services, have hobbled British trade over recent years, contributing mightily to our big external deficit. Being outside the EU will likely to boost our overall trade and growth, a reality independent analysts are increasingly accepting.

So the pound isn’t down because the UK is now definitely leaving the EU – and, by definition, the single market. Sterling is down because markets hate political rows and, with the focus shifted to Britain, traders have bored of exposing the fundamental incoherence at the heart of the single currency by bidding down the euro, and are for now fixated on the fundamental realities of the UK’s still very large external and internal deficits.

Talk of looser fiscal policy in the UK, promoted by Chancellor Philip Hammond at his party conference, as well as Prime Minister May, has further contributed to the pound’s weakness. Then there’s Bank of England’s odd decision to cut interest rates to 0.25pc in early August, despite clear signs the post-referendum UK economy was holding up rather well. Having lowered rates further, it will now be some time, after all, before the Bank can credibly put them back up – and finally begin the woefully overdue process of returning UK interest rate to non-emergency levels. Such considerations have also weighed on the pound.

Which brings us to this newish UK government’s attitude towards monetary policy more generally – negative interest rates and quantitative easing. Yes I know the Bank of England is “independent”, but the quotation marks are key because Governor Mark Carney, far moreso than his predecessor Mervyn King, is clearly among the UK’s most powerful political players.

I’ve detected, in numerous conversations with ministers over recent weeks, a growing impatience with and resentment towards UK monetary policy. The penny is finally dropping that QE – which began life as a £50bn emergency measure in 2009, and has since ballooned into a £375bn life-style choice – is damaging, confidence-sapping and extremely regressive.

Loved by the City, QE boosts share prices. Loved by the Treasury, the virtual money-printing rigs our sovereign bond market, allowing governments to keep borrowing with abandon. For years, that nexus of powerful vested interests closed down debate, making it almost impossible to question QE within financial, political and media circles.

Yet the on-going funny money has driven house-prices so high that co-habiting graduates (and potential Tory voters) can’t buy even a modest home, while long freaking out ordinary investors, the type who build things and create real jobs. And now financial markets themselves are increasingly questioning, as shares climb ever upward, if more money printing would be good news or bad news – a reason to celebrate, or a sign of panic.

Negative interest rates, meanwhile, already below zero in UK inflation-adjusted terms, and perhaps soon to be in nominal terms too, are also losing their “oh so clever” sheen. This is a policy that hammers savers, upends pension fund solvency and warps financial markets while also, at a time when banks are rebuilding, discouraging the commercial lending the economy so desperately needs.

Theresa May, in her conference speech, tried to signal her concerns about QE and the UK’s “Alice in Wonderland” monetary policy. “A change has got to come – and we are going to deliver it!” the Prime Minister declared. But what kind of change, and when? May and her team would like to think they can gradually withdraw from QE, weaning financial markets off the stimulants, and returning the UK to the sun-lit uplands, a “country that works for everyone” in the conference vernacular.

But, over at the US Federal Reserve, Ben Bernanke and now Janet Yellen have been trying that for years. The British media is focused on the intricacies of leaving the EU and the falling pound. But compared to unwinding QE, and coping with the worldwide financial, commercial and diplomatic shockwave that will unlease, Brexit is a piece of cake.


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